Payday Loans Are Dying. Problem Solved? Not Quite

Payday loans — the “lifesavers” that drown you in debt — are on the decline.

Fines and regulatory scrutiny over high rates and deceptive practices have shuttered payday loan stores across the country in the last few years, a trend capped by a proposal last summer by the Consumer Financial Protection Bureau to limit short-term loans.

Consumer spending on payday loans, both storefront and online, has fallen by a third since 2012 to $6.1 billion, according to the nonprofit Center for Financial Services Innovation. Thousands of outlets have closed. In Missouri alone, there were approximately 173 fewer active licenses for payday lenders last year compared to 2014.

In response, lenders have a new offering that keeps them in business and regulators at bay — payday installment loans.

Payday installment loans work like traditional payday loans (that is, you don’t need credit, just income and a bank account, with money delivered almost instantly), but they’re repaid in installments rather than one lump sum. The average annual percentage interest rate is typically lower as well, 268% vs 400%, CFPB research shows.

Spending on payday installment loans doubled between 2009 and 2016 to $6.2 billion, according to the CFSI report.

Installment loans aren’t the answer

Payday installment loans are speedy and convenient when you’re in a pinch, but they’re still not a good idea. Here’s why:

Price trumps time

Borrowers end up paying more in interest than they would with a shorter loan at a higher APR.

A one-year, $1,000 installment loan at 268% APR would incur interest of $1,942. A payday loan at 400% APR for the same amount would cost about $150 in fees if it were repaid in two weeks.

“While each payment may be affordable, if it goes for years and years, the borrower could end up repaying much more than what they borrowed,” said Eva Wolkowitz, manager at the Center for Financial Services Innovation.

You’re in the hole much longer

Payday installment loans are often structured so that initial payments cover only interest charges, not principal.

“The longer the loan is, the more you’re just paying interest upfront,” said Jeff Zhou, co-founder of Houston-based Fig Loans, a startup that makes alternatives to payday loans.

Add-ons add up

On top of high interest rates, lenders may charge origination and other fees that drive up the APR. Many also sell optional credit insurance — not included in the APR — that can inflate the loan cost. Lenders market this insurance as a way to cover your debts in case of unemployment, illness or death. But the payout goes to the lender, not the borrower.

About 38 percent of all payday installment borrowers default, according to the CFPB.

Americans still want small-dollar credit

The demand for payday loans in any form isn’t going away soon. Twelve million Americans use payday loans annually, typically to cover expenses like rent, utilities or groceries, according to The Pew Charitable Trusts.

“The original two-week loan originated from customers’ demand for the product. Likewise, customers in many cases are demanding installment loans,” Charles Halloran, chief operating officer of the Community Financial Services Association of America, a payday lending trade group, said in an email.

Income growth is sluggish, expenses are up and more Americans are experiencing irregular cash flow, said Lisa Servon, professor of city and regional planning at the University of Pennsylvania and author of “The Unbanking of America.”

“It’s a perfect storm that’s very good for the expensive short-term creditors, not so much for the average American worker,” she said.

What’s the alternative?

While Americans want small-dollar loans, 81% said they’d rather take a similar loan from a bank or a credit union at lower rates, according to recent Pew surveys.

Banks are waiting for the CFPB to finalize its proposed rule for payday lending before entering this market, according to Pew. As the fate of the CFPB remains unclear under the Trump administration, banks may not offer cheaper payday loans anytime soon.